Tracking the Aussie /Yen Carry Trade

The “yen carry” trade has permeated into all corners of the globe, and is especially attracted to higher yielding currencies, like the Aussie dollar. It’s been a wild rollercoaster ride, but Australia’s Stock Exchange (ASX-200) Index (EWA) has been catapulted to astronomical heights, in large part, due to the endless flow of cheap capital from Tokyo. The Aussie dollar (FXA) climbed 50% against the yen (FXY) from its lows in 2001, but found resistance at the psychological 100-yen last week.

The Aussie dollar also reached 84 US-cents, its highest in 17-years, helped by speculation the Reserve Bank of Australia [RBA]would raise its lending rate by a quarter-point from a six-year high of 6.25 percent. Last month, the RBA passed up a chance to lift its loan rate to 6.50%, despite explosive growth of the Australian M3 money supply, which is accelerating at a 14.3% clip, its fastest in 17-years.

Much like the Bank of Korea, the RBA is reluctant to raise interest rates further, to prevent the Aussie dollar from climbing above 100-yen. Japan is Australia’s largest trading partner, and Australian Treasurer Peter Costello is trying to talk down the Aussie dollar to help local exporters. Earlier today, the Australian government provided the central bank with at least three months of breathing space, by conjuring-up a surprisingly low +0.1% inflation rate in the first quarter.

That translates into a 2.4% annual inflation from +3.3% in Q’4, and is now within the RBA’s 1% to 3% target range for the first time in 12-months, taking pressure off the central bank for an immediate rate hike. The government’s fuzzy math showed a 34% plunge in fruit prices offseting a 13.3% spike in pharmaceutical costs, a 7.1% increase in school tuition fees, and higher home rents which climbed 1.4 percent. The drop in fruit prices was led by a whopping 73% plunge in banana prices.

But while government apparatchniks were lowering the consumer inflation statistics, the central bank admitted in February that the Aussie M3 money supply is out of control, expanding at an explosive 14.3% annualized rate, it’s fastest in 17-years. That had led to expectations of an RBA rate hike to 6.50% in April or May to rein-in M3. But the Aussie dollar’s strength against the yen, handcuffed the RBA.

The RBA had been gradually lifting its overnight loan rate for the past five years, from as low as 4.00% in Q’1, 2002 to as high as 6.25% in November 2006. But the RBA’s slow-motion baby-step rate hikes didn’t contain the run-away M3 money supply. Neither did the RBA slow down bank loan demand, which is 13.2% higher from a year ago. Without a further tightening in RBA monetary policy, inflation pressures in the Aussie gold market could continue to simmer at the boiling point.

Last year, the RBA intervened on a regular basis in the foreign exchange market, by selling A$3.6 billion, anxious to hold the Aussie dollar below the psychological 80 US-cents level. But “yen carry” traders and the Federal Reserve’s shift from a tightening bias to a neutral bias on March 21st, overwhelmed the RBA’s intervention efforts.

The stronger Aussie dollar against the deficit ridden US dollar and the ultra-low yielding Japanese yen, persuaded the RBA to keep its powder dry at 6.25% on April 3rd. But Sydney gold traders aren’t swayed by the government’s fuzzy math on inflation, and instead, are watching the growth of the M3 money supply.

Gold ended 0.8% higher in Sydney to A$634 /oz, following the surprisingly low inflation data, tracking a 14-basis point surge in Australian T-bill futures, which lowered the implied yield for June to 6.42%. The inflation report was a shocker for Sydney T-bill futures traders, leaving a huge gap on the daily charts, while scaling back expectations of an RBA rate hike to the fourth quarter.

Treasury chief Costello said Australian inflation hit a peak in the middle of last year and appears to have decelerated. “The headline inflation rate will go lower. You will see a headline rate next quarter below 2 per cent,” he declared. Ironically, with the RBA handcuffed on rate hikes by the Treasury chief, Sydney gold traders have a green light to bid the yellow metal higher in the weeks ahead.

Ordinarily, sharply lower interest rates would be construed as bullish for blue-chip stocks. But the ASX-200 ended 20-points lower after the benign CPI report, because “yen carry” traders unwound long positions in Aussie stocks, while the Aussie dollar came under selling pressure vs the yen. The ASX-200 Index is in the hands of “yen carry” traders, and the psychological 100-yen level for the Aussie$, proved to be a barrier for the ASX-200 Index at the 6,250-level, an all-time high.

With so much riding on the Aussie /yen exchange rate, it’s interesting to note that the interest rate differential between the six-month Aussie Libor and the Japanese yen Libor shrank to +560 basis points from +588 basis points after the release of the CPI data. Still, the Aussie dollar retains a wide interest rate advantage over the yen, and carry traders could look to buy the commodity currency again at the next support level. The next Bank of Japan rate hike to 0.75% is not expected until June.

Comments

[the.orange....:]

Quote "Gold ended 0.8% higher in Sydney to A$634 /oz" a small point but that should be $834, no?

2007 Apr 26 07:14 PM